061013 Navigating the New Normal R6 PE

7/28/2019 061013 Navigating the New Normal R6 PE

1/24

2013 Wharton Private Equity Review

Navigating the

New Normal

July 2013

http://knowledge.wharton.upenn.edu


2/24

Sponsored By

Wih aiial u fm

Private Equity and Venture Capital Club

TH E W HA RTON SC HO OL


3/24

2013 Wharton Private Equity Review:

Navigating the New NormalSome $200 billion of new capital went to private equity and venture capital management partnerships (collectively

referred to here as PE) throughout the world in 2012. For the first time, 20% of that total, some $40 billion, went to

fund managers in emerging market countries. Surprisingly, of that $40 billion, only $15 billion went to the subset of

emerging economies known as the BRICs (Brazil, Russia, India and China). That leaves $25 billion that went into the

non-BRIC emerging markets.

So where did the rest of it go? Countries like Columbia, Chile, Peru and Mexico have seen remarkable growth.

Several African countries, such as South Africa, Kenya and Nigeria indeed, the whole of sub-Saharan Africa

have witnessed growth in the number of fund managers and the capital under management. Turkey also has

emerged as a destination, as have Malaysia, Thailand, Vietnam and now Indonesia.

These new players still have work to do in improving their PE ecosystems. Management capacity building is highon the list, as are appropriate laws and regulations, tax treatment and acceptance of contractual provisions. These

countries governments have recognized the role of PE in their industries and are motivated to make the needed

changes. There is a discernible transfer of knowledge from mature economies to the emerged and emerging market

PE players.

These trends are reflected in two of the articles included in this years Wharton Private Equity Review. One offers

coverage of a panel discussion titled, Private Equity Survival Guide: How to Survive and Thrive in Emerging

Markets, which took place at the 2013 Wharton Private Equity & Venture Capital Conference. The second, written

by a team of five Wharton MBA students, focuses on the impact of the Arab Spring on private equity in the Middle

East and North Africa (MENA) region.

Beyond emerging markets, this years review includes a piece by a Wharton MBA student that looks at how the

regulatory scrutiny of the PE industry in the United States has evolved dramatically over recent years. The industry has

moved from a lightly regulated, self-governing asset class to one that is coming under increasing scrutiny and reporting

requirements. The author speculates on what is in store for the industry as regulators continue their investigations.

An example of international activity is presented in a case study by another Wharton MBA student, titled Investing

in Times of Distress: the Bank of Ireland and WL Ross, which provides a detailed overview of how PE investors

have played a role in the recapitalization and restructuring of troubled financial institutions.

Knowledge@Wharton then reports on another panel from the conference that addressed how PE firms create

value and questioned some of the common wisdom surrounding the roles and actions of PE firms once they have

acquired a company. Finally, a piece on venture capital from another conference panel then looks at the challengeof generating consistent returns and the growing allure of New York City over Silicon Valley.

The story of PE and venture capital in mature economies and the emerging markets does not end here. PE activity

has now blossomed in virtually every region and is reinvigorating entrepreneurship, companies and entire industrial

sectors. We hope that we have captured some of this excitement and challenged preconceptions at the same time.

Stephen M. Sammut, Senior Fellow, Wharton Health Care Management and Lecturer, Wharton Entrepreneurship
http://www.whartonpeconference.org/http://www.whartonpeconference.org/


4/24

ContentsFast-growing Middle Classes in Emerging Markets Lure Private Equity 3

During the 2013 Wharton Private Equity & Venture Capital Conference, a panel of leading

private equity players explained how they have harnessed opportunities in emerging

markets, even though tough regulations and shifting market dynamics present hurdles

at every turn. Panelists reviewed the real and perceived risks of investing in these fast-growing markets, and described how some of them provide particularly fertile ground for

nurturing investments.

The Arab Spring and Private Equity: Time to Take the Plunge? 5

Many international investors might prefer to stay far away from the Middle East and

North Africa, especially after the Arab Spring rocked the region. But others are cautiously

optimistic about prospects for the area. Some believe the Arab Spring has presented savvy

investors with an unprecedented opportunity to snap up quality assets at deep discounts.

Is now the right time to invest?

Very Public New Regulations for a Very Private Industry 9

Private equity (PE) firms are either going to sink or swim as new financial regulations

bear down on the industry. Intense scrutiny from regulators and the media has altered the

industry landscape, making the once opaque sector now uncomfortably transparent for

some. A look back at the evolution of the regulations and the increased media coverage of

recent years sheds some light on how PE managers can adjust to the new normal.

Investing in Times of Distress: The Bank of Ireland and WL Ross 12

A group of American and Canadian private equity investors, led by the influential billionaire

Wilbur Ross, set an example for the industry when they made a $1.45 billion (1.1 billion)

investment in the struggling Bank of Ireland in 2011. The deal, completed at a fire-sale price,shows that other investors may be able to pick-up similar bargains in Europe as credit and

sovereign debt crises continue to rage across the region. What are the key lessons from the

Bank of Ireland transaction, and how might they apply in other situations?

How Do Private Equity Firms Create Value? 15

Private equity (PE) isnt simply about buying a company, throwing out management and

making dramatic changes to ensure the company is on the right track. The process is

far more nuanced. A panel of PE experts gathered at the 2013 Wharton Private Equity &

Venture Capital Conference in Philadelphia to discuss best practices when it comes to

value creation. The panel revealed some tried-and-true methods for working successfully

with the management of acquired companies to ensure goals are aligned and strategies areexecuted in a way that ensures companies flourish.

Venture Capital: The Art of Picking the Few from the Many 19

Venture capital investors may be the funders behind the next Facebook or PayPal, but

most of the time, their investments lead to dead ends. This makes it difficult to generate

consistent returns. At the recent Wharton Private Equity & Venture Capital Conference in

Philadelphia, panel members discussed this thorny challenge and others, and also cited

potential opportunities for the sector, with a focus on the growing allure of New York City

over Silicon Valley.


5/24Navigaig h Nw Nmal

E ks s cc- that tends to suggest outsized risks and the

potential for outsized investment returns. But for

private equity (PE) firms, this broad term masks

the wide-ranging differences between distinctive

markets. Large emerging countries like China and

India are very different from smaller ones likeBolivia and Paraguay.

So how do PE firms that specialize in emerging

markets find opportunities that justify the risks? Its

not an exact science, according to speakers who

participated in a panel discussion on emerging

markets at the 2013 Wharton Private Equity & Venture

Capital Conference, but the most appealing markets

do share some characteristics, like a growing middle

class and business-friendly government.

Some countries, such as Brazil, Russia, China and

India (which are also known as the BRICs), are

obviously further along in the process of emerging

than others, and have a track record of profitable

PE investments as an indicator of their markets

potential, said Ralph Keitel, principal investment

officer of the International Finance Corp. (IFC),

the private sector arm of the World Bank Group

that invests in PE funds. The IFC invests $12

billion to $15 billion a year, and has a dual goal of

earning investment returns and aiding economic

development in emerging markets.

Understanding a countrys pros and cons takes agranular examination, he added, because a single

country may be relatively well developed in some

geographical regions, whereas 500 miles to the

north or south, people are living in abject poverty.

China is a prime example, he pointed out, with

vast differences between the developed coastal

cities and the poor rural inland areas. It would be a

mistake to assume that all of China presents great

PE opportunities.

Emerging markets that appeal to PE firms do tend

to share some other features as well, said Enrique

Bascur, managing partner of Citigroup Venture

Capital International (CVCI). The one thing that

they have in common is a higher than average

growth rate, he noted. But a high growth rate is not

enough if the countrys economy is small, he added.

That is why countries like Brazil, Mexico, Chile,

Peru and Columbia are attractive, but Bolivia and

Paraguay are not.

Health Care Opportunities in EmergingMarkets

Stephen M. Sammut, a Wharton lecturer and

partner at Burrill & Company, a venture capital firm

focused on the life sciences and health care, saidhis firm looks for markets that offer growth and

consolidation of the middle class. They also look

for markets where it is clear that the government

policies are moving toward seeing health as a

human right. A good market has a culture that

encourages innovation and offers a favorable legal

environment that provides basics such as contract

enforcement, he noted.

Burrill also looks for countries that already have an

established foundation in health care, he said. For

example, India has a thriving generic medication

industry eager to do research, and the government

has made it easier for medical research firms to

conduct drug trials, Sammut noted.

Keitel said the IFC prefers to invest in a business

that, instead of doing what its competitors are

doing, can move to the next level. Some markets,

for instance, have companies that provide raw

Fast-growing Middle Classes in Emerging Markets Lure Private Equity
http://www.whartonpeconference.org/panels.phphttp://www.whartonpeconference.org/panels.phphttp://entrepreneurship.wharton.upenn.edu/teaching/faculty/sammut.htmlhttp://entrepreneurship.wharton.upenn.edu/teaching/faculty/sammut.htmlhttp://www.whartonpeconference.org/panels.phphttp://www.whartonpeconference.org/panels.php


6/24Kwlg@Wha 2013 Wharton Private Equity Review

4

While a country at the early stages of emerging

might seem like virgin territory that is ripe with

opportunity, it can be useful to have company in the

PE space, Sammut observed, noting that indigenou

PE funds are now forming in some emerging

markets. In my view, thats been a very positive

trend, he said.

Much is often made of the risks of investing in

emerging markets. There can be unstable currencieand governments, shaky legal systems, corruption

and even warfare. But a closer look often reveals a

difference between perceived risk and real risk,

Keitel said. Revolutions in Cairo and Tunis made

headlines around the world, but had little effect on

PE firms operations in those cities, he pointed out.

A PE Home Run

The panels moderator, Timothy J. Hartnett, leader

of the U.S. private equity sector at PwC, an auditing

and consulting firm, asked for examples of home

runs in emerging markets.

Bascur provided one stand-out example: in the earl

2000s, CVCI was approached by investment banker

seeking a buyer for a family-owned salt mine in

Chile. In the wake of the Internet boom, this seemed

like an out-of-the-ordinary opportunity that was

about as low-tech as a business can get.

This salt mine happened to be in the most

economical place in the world to produce pure salt,

he recalled. The salt lay on the surface only about

10 miles from the ocean, in a place where it almost

never rains. Because this salt was so cheap to

produce, CVCI saw a chance to capture a large shar

of the U.S. market for road salt for municipalities,

airports and other big users.

The salt mine was purchased for $100 million, and

CVCI then bought a Brazilian distribution company

to help get the salt to market. After a few years, the

operation had captured about 50% of the U.S. road

salt market, and the firm was sold for $500 million.

This case was a classic example of an emerging

market PE strategy that brought together firms indifferent emerging markets to serve customers in

developed ones, he said.

4

materials for medications, and the IFC tries to help

them develop the expertise to produce finished

products. A firm in one country might produce a

drug, while a firm in another makes the syringe

needed to administer it. That would be an example

of how we see various parts of East Asia work

together, he said.

Different Markets, Different Strategies

The key to PE success in emerging markets is

the ability to adapt, according to Keitel. Investors

must be able to adapt to wide variations that

distinguish one market from another. Cookie-

cutting in emerging markets is not a good strategy,

he said. We believe all business is local. We want

to back [general partners] who have a very deep

understanding of the market, who understand the

culture, who have networks there.

For example, it takes very different strategies to

invest successfully in Central America, where the

capital markets are undeveloped, compared to

South Africa, which has well-established capital

markets and a fairly well-developed PE industry,

said Keitel.

Business cultures also differ from one region to

another, he added. In China and India, the PE firm

often takes a minority stake because, for the target

companys founder, retaining control is a very

important issue. Its more common for PE firms to

take a controlling stake when they operate in Latin

America, he noted.

On-the-Ground Presence is Optional

While it is important to have a deep understanding

of local markets, this doesnt necessarily mean a

PE firm must set up an office in every country in

which it operates, said Bascur. You can have an

office there and notbe local ... or be outside and

understand it perfectly well, he explained. CVCI

prefers to set up hub offices that serve multiple

countries, he noted. These offices have the size,

or critical mass, that allows them to work more

effectively compared to a multitude of small offices

with skimpy resources. Typically, the hub is staffed

by people from the various countries it serves,

added Bascur.



S sp f 2011, Middle East and North Africa (MENA) experienced

a wave of protests, revolutions and even civil wars

that continue to this day in some parts of the region.

The Arab Spring has led to four governments being

overthrown across the region, and many others

offering political and economic concessions to theirpopulations in response to growing disturbances

and unrest. While uncertainty has grown for the

entire region, many observers believe that greater

stability will eventually bring about democratic

governments and reform.

How has the Arab Spring affected the private equity

(PE) industry in the MENA region, particularly in

regards to investor appetite, investment decisions,

fundraising, competition and global attitudes? What

are the future investment prospects and what kinds

of investors stand to benefit from the Arab Springupheavals? Below are some insights:

A Time for Reform and a Time to Rebuild

Developing markets generally present PE investors

with many challenges, including under-developed

intellectual property rights protections, poorly

functioning financial markets and a lack of public

infrastructure. These issues, combined with the social

and political unrest in the MENA region, would

suggest a poor environment for private equity.

According to data from consulting firm Geopolicity,

unrest related to the Arab Spring is estimated to havedirectly wiped out billions of dollars from the regions

gross domestic product (GDP).

But surprisingly, MENA private equity practitioners

have been cautiously optimistic. The Arab Spring

was spurred primarily by the populations

disenchantment with the regions autocratic

governments, political policies and economics.

Resulting political and economic reforms will

require billions of dollars of public investment,

which could potentially pave the path for a more

private equity-friendly future.

The full cost of repairing the damage and instituting

massive reforms in the Maghreb region alone is

expected to be $300 billion over the next 10 years,

according to a an article in La Maghreb Daily.Saudi Arabia has already enacted a wider public

investment and transfer payment program that is

estimated to have cost $30 billion, the International

Monetary Fund (IMF) reported.

Substantial foreign aid is also expected: The G8

pledged $20 billion to Egypt and Tunisia during the

May 2011 Deauville summit, and the oil-rich nations

from the Gulf Cooperation Council pledged an

additional $20 billion to help Oman and Bahrain. In

addition, the IMF pledged $35 billion to emerging

Arab democracies, and is already in the processof disbursing loans. Thankfully for institutional

investors, the IMF money comes with strict terms

about how these funds should be used, and these

policies will likely benefit investors.

It is worth noting that while a large part of the

investment opportunity stemming from the Arab

Spring revolves around direct spending and

aid increases, the political and social reforms

are arguably more important. The MENA region

represents a huge market with an aggregate GDP

of $2.5 trillion that is comprised of many autocratic

states where PE faced difficult conditions well in

advance of the Arab Spring. Even without any direct

spending increases, simply gaining access to these

markets represents a huge win for PE.

For example, in Morocco, the monarchy gave up its

divine rights and introduced a new constitution that

better shields the countrys citizens and investors

from autocratic capriciousness. In Egypt, the fall

of former President Hosni Mubarak has opened up

The Arab Spring and Private Equity: Time to Take the Plunge?
http://en.lemag.ma/Investment-Opportunities-in-North-Africa-post-Arab-Spring_a630.htmlhttp://europa.eu/rapid/press-release_MEMO-11-353_en.htmhttp://europa.eu/rapid/press-release_MEMO-11-353_en.htmhttp://en.lemag.ma/Investment-Opportunities-in-North-Africa-post-Arab-Spring_a630.html


8/24Knowledge@Wharton 2013 Wharton Private Equity Review6

unprecedented personal and economic liberties

that could potentially result in a better distribution

of wealth and power, more reliable civil institutions

and pave the way for growth in consumption and

investment.

A key realization is that business opportunities

in the MENA region were significantly depressed

relative to developed markets because risk-takers

could not reliably build businesses in the politicalclimate that existed pre-Arab Spring. Furthermore,

non-oil-rich MENA nations were relatively

inaccessible and citizens were very poor, which

is not ideal for investors. When starting from

such a beleaguered base, the prospect of public

investment, foreign aid and socio-economic

liberalization paves the way for significant

opportunities for patient investors. But how have

PE investors fared thus far, and how will they

participate in the MENA economy going forward?

The Arab Spring and Private EquityAlthough there is no proof for causation, recent

data from the Emerging Markets Private Equity

Association (EMPEA) and the IMF seem to indicate

that both economic growth and private equity

investments in MENA decreased in the first year

of the Arab Spring at a much faster rate than in

developing economies that were not affected by

such unrest.

IMF data shows GDP in 2011 in emerging markets

grew by an average rate of 6% as opposed to only

3% in the MENA region. GDP growth was slowing inall emerging markets and developing economies at

this time, but it was far worse in the MENA region.

Furthermore, according to the EMPEA, the capital

invested in 2011 in the MENA region amounted to

$385 million, down 52% from 2010. The number of

deals that were closed, however, stayed relatively

the same: 23 in 2010 versus 22 in 2011, which

suggests that it was the size of the deals that

ultimately changed. Indeed, the data shows there

were a handful of investments in 2010 that exceeded

$300 million, but no large deals in 2011.

Since 2011, the data points to signs of a recovery

in the PE investment landscape. After a subdued

year for fundraising and investment activity in 2011,

private equity in the MENA region exhibited signs

of recovery in 2012, with new capital commitments

and capital invested increasing by 29% and 303%,

respectively, noted a recent EMPEA report.

The upswing in investment can largely be

attributed to an $855 million equity infusion in

Dubai-based Shelf Drilling by the consortium of

CHAMP Private Equity, Castle Harlan and Lime

Rock Partners. However, the total number of MENA

investments doubled in 2012, with most of the

increased deal flow in the venture capital and small

and medium-sized enterprise market segments,

stated the EMPEA.

According to data from business intelligence site

Zawya, deals worth $362 million were closed in

the first six months of 2012, compared to only $46

million in the same period a year prior, which was

during the height of the Arab Spring revolutions.

PE professionals agree that a recovery has started.

MENA-focused PE fund Amwal AlKhaleej has noted

that, in the short term, the Arab Spring increased

risk premiums and decreased liquidity and

valuations, but now risk premiums are declining an

liquidity is staging a recovery. It seems the region

has also become more attractive to incumbent

investors due to lower levels of competition.

We see Egypt as more favorable than before the

revolution because the competition has backed off,

Romen Mathieu of the Lebanese fund EuroMena II,

said in an interview with the Economistmagazine.

Furthermore, a February 2013 survey by the

Economist Intelligence Unit (EIU) shows executives

have an overwhelmingly positive business outlook

for the MENA region. Executives in the Middle Eas

and Africa are particularly upbeat. More than a third

believe business conditions will improve during thenext six months; almost two-thirds expect their firm

to boost capital spending in 2013. In addition, GDP

growth in 2012 rose to pre-Arab Spring levels.

The data on increased PE investment activity

coupled with the overall upbeat business and

economic outlook are positive indicators of the

industrys recovery. But is new capital staying on th

sidelines due to the Arab Spring?

Fundraising: Temporary or Permanent

Impact?In the MENA region, fundraising declined from

just over $4 billion in 2007 to $1.2 billion in

2009, according to a report from Private Equity

International. Since then the amount of capital

raised for funds targeting the region has remained

under $1 billion. In 2012, funds targeting the region

had extreme difficulty raising enough to meet their

capital targets.
http://www.zawya.com/story/USD362m_PE_deals_in_H12012-ZAWYA20120722103953/http://www.peimedia.com/resources/Connect/MENA%20Private%20Equity%20Review%20April%202012.pdfhttp://www.peimedia.com/resources/Connect/MENA%20Private%20Equity%20Review%20April%202012.pdfhttp://www.peimedia.com/resources/Connect/MENA%20Private%20Equity%20Review%20April%202012.pdfhttp://www.peimedia.com/resources/Connect/MENA%20Private%20Equity%20Review%20April%202012.pdfhttp://www.zawya.com/story/USD362m_PE_deals_in_H12012-ZAWYA20120722103953/


9/24Navigating the New Normal

Meanwhile, a private equity report by Grant

Thornton found that only a small minority of MENA

general partners (GPs) felt positive about raising

new funds in 2012. Many investors pointed to a

divided market where top-performing managers

raised funds with relative ease, while the rest

struggled. However, this is better than in the BRIC

countries and in the Asia-Pacific region, where even

more respondents thought it was challenging to

raise new funds.

The contraction in the number of GPs active in the

region has also contributed toward the decrease

in capital raised, with a high number of firms not

being able to survive due to harsh conditions. A

large number of GPs also focused their efforts away

from fundraising, instead working to ensure the

success of their portfolio companies despite the

difficult financial climate.

According to Deloittes 2012 MENA survey,

two-thirds of respondents believed that the global

limited partner (LP) appetite for the MENA area

will remain at the same subdued levels due to

continuing market instability and an uncertain

political environment. There is a belief that the

media exaggerates the regional uncertainty, keeping

global investors at bay indefinitely.

By 2012, there were promising signs of a recovery

despite the ongoing turmoil. Investors are

increasingly looking at Egypt, Tunisia and Saudi

Arabia as attractive hubs for investment. The smaller

number of private equity firms in the region has

also led to more favorable conditions because oflower competition for LP capital. There has also

been a positive shift in the balance between capital

raised and investment opportunities.

There are hopes that the Arab Spring could lead to

positive changes in the way the industry operates.

Investors anticipate the aftermath of the political

unrest will bring greater transparency in deals and

allow more investment opportunities to open up.

Concerns Remain

Despite this positive news, the consensus is thatLPs are not confident that investments in the MENA

region will be profitable. Political and economic

risks are among the main factors LPs consider

when deciding to invest in a MENA-focused fund.

In an area heavily affected by political unrest, it

is important for LPs to be able to rely on fund

managers to have an excellent understanding of the

investment landscape.

When asked about their investment appetite

following the Arab Spring, one recent survey

found the majority of LPs (58%) and GPs (85%)

said they intend to keep their investments in the

region unchanged as part of a longer-term strategy.

Of those who responded that the Arab Spring

would affect their investment in the region, LPs

are more cautious towards investment in MENA,

with 12.5% of respondents considering decreasing

their allocation to the region. Meanwhile, no GPs

indicated that they wish to do the same. However, a

larger percentage of LPs than GPs are considering

increasing their investment or newly investing in

the MENA region, with over 29% of LPs responding

positively as opposed to only 15% of surveyed GPs.

Simultaneously, some LPs remain concerned about

financial stability following the Arab Spring and

are increasingly demanding a soft commitment

option that allows them to veto individual

investments. Its too early to tell what the lasting

impacts of the Arab Spring will be, but theseshort-term consequences are certainly being felt in

private equity markets. Over half of surveyed GPs

felt that the short-term implications for fundraising

were negative for launching new funds, fundraising

for existing funds and reaching a final close.

However, several GPs feel that there will eventually

be a positive impact on investing in portfolio

companies, earnings of portfolio companies and

exit opportunities. This is mostly due to lower

valuations and new sectors being opened up to

private investors

The Future of MENA Fundraising

Changing Power Dynamics: The changes in the

MENA region have contributed to shifting the power

dynamic from GPs to LPs. LPs have increased their

demands in the fundraising process and asked

for more transparency, due diligence and lower

management fees. This trend will likely continue into

the near future as fundraising conditions remain

challenging. Additionally, the increased LP demands

will have another side effect increasing the gap

between winning and losing funds by exacerbating

the already limited back-office resources of

underperforming funds.

Sources of Capital: According to the Grant Thornton

Global Private Equity Report 2012, roughly one

third of the LPs who invested in MENA funds are

domestic. Domestic investors have been the most

active since they have critical local expertise and

contacts. LPs outside of MENA will remain cautious
http://www.gti.org/files/global_private_equity_report_2012.pdfhttp://www.gti.org/files/global_private_equity_report_2012.pdfhttp://www.gti.org/files/global_private_equity_report_2012.pdfhttp://www.gti.org/files/global_private_equity_report_2012.pdf



8

about placing capital in the region due to several

factors, including perceived political instability,

attractive opportunities in other emerging markets

and a lack of performance history from local fund

managers. According to Deloittes MENA Private

Equity Confidence Survey 2012, many experts

believe that it could be 2014 before international LPs

become comfortable with investing in MENA. Given

all of these factors, a significant portion of capital is

likely to continue to be sourced domestically.

LPs in the region are heavily weighted toward

family offices since a single family can oftentimes

be a dominant investor in the region. Given

distributions of wealth in the region, this trend is

likely to continue. Almost half of all respondents to

the Deloitte survey estimate that family offices will

be the most active investors over the next year.

The Rise of Sovereign Wealth Funds: The region

will also likely see a rise in activity from sovereign

wealth funds (SWFs), according to a paper by

Private Equity International. These SWFs are

increasingly looking to deploy capital to alternative

assets with higher returns, and private equity is

an ideal candidate. Global SWFs are also growing

their assets quickly: In 2012, SWFs around the world

had $4.62 trillion of assets under management,

a 16% increase from 2011, according to a report

from Financier Worldwide. Consulting firm Bain &

Co. estimates that over the next few years, the 10

largest SWFs with private equity exposure will inject

up to $60 million in the asset class. The increased

interest in private equity from the largest SWFs

could encourage smaller SWFs to follow suit.

Meanwhile, the majority of SWFs that invest in

private equity are based in Asia and MENA, which

could bode well for private equity in the MENA

region since investors may be more confident to

invest in their own backyards. It doesnt hurt that

MENA SWFs tend to receive steady streams of

capital from oil resources and have relatively long

investment time horizons.

SWFs enjoy enormous flexibility as PE investors,

said Bain in its 2012 global private equity report.Unlike conventional LPs, which try to match the

duration of assets and liabilities in order to meet

their need for liquidity, SWFs can patiently commit

capital over long time horizons.

Managing Regional Risk

Some recent global trends suggest investors are

increasingly trying to mitigate the risk of local

investments. First, it seems SWFs with private

equity exposure are focusing more on investing

in multi-manager vehicles. In 2012, a report in

Financier Worldwide showed nearly one-third of

SWFs said they preferred investing in PE equity

funds-of-funds, up from 20% in 2011. Clearly, SWFs

are hoping to minimize their risk by diversifying.

Second, PE investors in MENA are beginning to

prefer investing on a deal-by-deal basis rather than

invest in blind pools of funds, according to Deloitte.

Global investors also seem to have more stringent

investment criteria, which could serve to increase

transparency and decrease risk over time.

Conclusion

Unsurprisingly, the Arab Springs short-term impact

on PE was negative. Both investing and fundraising

activity fizzled out as the MENA region experienced

unprecedented levels of unrest. But this reduced

activity was followed by cautious optimism from

those who were knowledgeable about the region.

Unrest has paved the way for reform and, in the

process, a large region is now slowly being opened

up for PE investment. The industry is already seeing

signs of recovery from the 2009 and 2010 doldrums

and significant government and foreign funding,

coupled with consumer markets that are poised to

grow, set the stage for resurgence in private equity

investments.

But the benefactors of this resurgence are unlikely

to be outsiders and international PE leaders.

Foreigners are more likely to view the Arab Springas a cataclysmic event and less as an investment

opportunity. Instead, insiders and domestic

professionals could be the main beneficiaries.

PE players that already have a significant presence

and experience in the MENA region will be best

poised to benefit from any recovery. Meanwhile,

fundraising is still at low levels, meaning that

only firms with adequate dry powder can take

advantage of the lack of competition and depressed

asset valuations.

Thus, PE players who are in the know willdisproportionally benefit from the Arab Spring

as they leverage existing knowledge and funding

resources to capitalize on what may be an

unparalleled investment opportunity in the region.

This article was co-written by Mila Adamove, Rehi

Alaganar, Alia Avidan, Jagan Pisharath and Terry

Wang members of the Wharton MBA Class of 2013
http://www.financierworldwide.com/article.php?id=9414http://www.financierworldwide.com/article.php?id=9414http://www.bain.com/bainweb/pdfs/Bain_and_Company_Global_Private_Equity_Report_2012.pdfhttp://www.financierworldwide.com/article.php?id=9414http://www.financierworldwide.com/article.php?id=9414http://www.bain.com/bainweb/pdfs/Bain_and_Company_Global_Private_Equity_Report_2012.pdfhttp://www.financierworldwide.com/article.php?id=9414http://www.financierworldwide.com/article.php?id=9414


11/24

with Accounting Standards Update 2011-04, which

sought to increase transparency by requiring funds

to provide detailed disclosures of the estimates,

assumptions and supporting documentation used in

all fair value models.

In what now looks like a clear foreshadowing

of future actions, the Securities and Exchange

Commission (SEC) announced in August 2009

the eventual reorganization of its Division of

Enforcement into five specialized units designed

to enhance the its ability to protect investors. The

largest of the newly specialized units, the Asset

Management Unit (AMU), focuses on investment

advisers and companies, including PE funds.

The AMU is staffed with 75 full-time employees,

including PE industry experts, and uses advanced

risk analytics to detect problematic fund conduct.

The Dodd-Frank Wall Street Reform and ConsumerProtection Act, signed into law in July 2010,

brought sweeping changes across many areas

of the financial services landscape, including

PE. Dodd-Frank eliminated the private adviser

exemption, requiring most PE firms to register with

the SEC by March 2012. Dodd-Frank also included

the Volcker Rule, which limited banking entities to

owning no more than 3% total interest in alternative

asset funds, in addition to limiting their investment

in alternative asset classes to no more than 3% of

the banks Tier 1 capital.

The full force of these regulatory actions was

revealed in September 2011, the first complete

fiscal year under the SECs finalized restructured

enforcement program, when the agency filed a

record 146 enforcement actions against investment

advisers, a 30% increase over the prior year and a

92% increase over 2009. This marked the beginning

of the end for PEs private persona.

F y ys, p quy (PE)relied on light-touch regulation and self-governance,

which kept the industry out of the limelight. Those

halcyon days now seem to be over.

The passage of a wave of new regulations has

opened the door for a new era of post-crisis scrutinyon the once-opaque PE industry. The net effect has

placed PE more in the spotlight, in the same way

that hedge funds and the big Wall Street banks have

garnered more attention.

Demands for enhanced transparency have grown

louder over time, bolstered by the media blitz of

the last election cycle, increasing allocations from

public pension funds and Main Streets growing

exposure to PE via financial sponsor IPOs.

A look back at developments over the last few years

sheds some light on this new world of scrutinyand provides more information about the efficacy,

efficiency and continuing evolution of regulatory

actions.

Transformative Rules and Regulations

PEs protective shell first began to wear thin in

September 2006, when the U.S. Financial Accounting

Standards Board adopted the Statement of Financial

Accounting Standards No. 157 (SFAS 157), which

clarified the meaning of fair value in generally

accepted accounting principles (GAAP) as the price

that would be received to sell an asset or paid to

transfer a liability in an orderly transaction between

market participants at the measurement data.

This was a huge change: It directed PE firms to

mark-to-market their portfolio holdings instead

of holding them at cost. The mechanisms around

fair valuation were further outlined in May 2011

Very Public New Regulations for a Very Private Industry

Navigaig h Nw Nmal



In October 2012, the SEC announced that newly

registered private fund advisers would have to

conduct a series of presence exams administered

through the commissions National Exam Program.

According to the SEC, the exams would review

certain high-risk areas. Focus areas included

valuation, marketing, security of client assets and

portfolio management. Any serious deficiencies

would result in an examination summary letter and

potential action by the Division of Enforcement.

It does not take a massive leap of faith to believe

that the recent increase in the carried interest

tax rate was facilitated by this new era of PE

scrutiny. Carried interest is the share in profits

that PE managers take as compensation when

their investments perform well, and is classified

as a long-term capital gain, which is taxed at a

significantly lower rate than the ordinary income

tax rate. In the recent budget deal, lawmakers

increased the top rate on long-term capital gains

from 15% to 20%. It is still very possible that capitagains may eventually be taxed as ordinary income.

According to the Joint Committee on Taxation, such

a rate change would result in additional governmen

income of $16.8 billion over 10 years.

Whats Next for the Industry?

It does not seem that the tide of media attention,

regulatory scrutiny, and public speculation directed

at PE will abate anytime soon. This sentiment was

affirmed by AMU co-chief Bruce Karpati, who in

January 2013 at the Private Equity International

Conference said, Its not unreasonable to think tha

the number of cases involving private equity will

increase.

A near-term focus for the AMU will be identifying

zombie managers, defined as fund managers who

have been unable to raise follow-on investments.

The SECs thesis is that while most zombie

managers will continue to act in the best interest

of their investors, there will be others who will

be incentivized to shift priorities and focus far too

much on maximizing their own revenue to the

detriment of others, leading to problematic conductand possible regulatory violations.

This new normal of increased regulatory

oversight and media scrutiny will lead many PE

managers to wonder how to conduct themselves

and their businesses in the future.

Robert Rapp, a partner at the law firm Calfee, Halter

& Griswold LLP, explains that, going forward,

Taking to the National Stage

With Mitt Romneys ascension in late 2011 as a

leading candidate for the Republican nomination for

President, his background as chief of Bain Capital

served as a lightning rod of criticism against the

PE industry from both Democrats and competing

Republicans. The popular critiques portraying PE

managers as tax-avoiding corporate raiders who

profit via massive lay-offs, cost cutting, and over-leveraging, gained widespread media attention for

the first time.

In December 2011, as media attention on Romneys

candidacy intensified, the SECs enforcement unit

sent letters to several leading PE firms as part of

an informal inquiry into the industry. The SECs

stated goal was to investigate possible violations

of federal securities laws as well as to deepen

the commissions understanding of myriad issues

related to the industry, including how PE firms value

investments, impose fees and allocate costs.

The enforcement unit had been heavily criticized

in the past for its ineffectiveness in regulating the

financial services industry in the period leading to

the worldwide economic downturn, and has since

taken a more aggressive, public stance in its vow to

eradicate corruption and impropriety on Wall Street.

The AMUs co-chief, Robert Kaplan, explicitly

put the PE industry on notice at a conference in

January 2012 when he said that Private equity

law enforcement today is where hedge fund law

enforcement was five or six years ago. This wasa warning for the industry to expect increased

attention and enforcement going forward.

Armed with a clear focus, the requisite manpower

and powerful new analytical tools, Kaplan

and the AMU set upon a mission to police the

previously self-regulated industry. The AMU

used the Aberrational Performance Inquiry (API),

a proprietary risk analytics engine, to highlight

areas for further review. The API helped analyze

funds investment strategies and other benchmarks

to evaluate returns and highlight inconsistent

performance. By December 2011, the API had

already been credited with six enforcement cases.

In the months that followed, more inquiries and

enforcement actions would take place pertaining

to a host of private equity activities, including

overstatement of portfolio fair value, insider trading,

cherry picking, price collusion, misallocation

of transaction and portfolio expenses and

misstatements made to limited partners.



it will be up to private equity managers to look

through the lens of fiduciary duty to understand

expectations, identify and resolve conflicts of

interest, and know what drives enforcement.

PE firms must strive to have well-documented,

consistent, and transparent policies and procedures,

while bracing themselves for the tangled web of

uncertainty, disagreement and frustration that

comes with an evolving regulatory landscape.

This article was written by John Daly, a member of

the Wharton MBA Class of 2013.


14/24

12Kwlg@Wha 2013 Wharton Private Equity Review

Investing in Times of Distress: The Bank of Ireland and WL Ross

T cd d s db css fthe past few years continue to profoundly reshape

the financial landscape across the developed world.

One of the most visible consequences from this

difficult era has been the incessant restructuring

of major European financial institutions. With low

investor risk tolerance, capital-starved governments,

and European banks facing the twin headwinds of

ongoing economic weakness and more stringent

regulation and capitalization requirements,

compelling opportunities for well-positioned private

equity (PE) investors look likely to remain abundant.

In July 2011, a group of investors, led by turnaround

specialist WL Ross & Co., recognized this

opportunity and announced they would purchase

roughly 35% of Irelands largest bank, the Bank

of Ireland (BOI). The price tag for the transactionwas $1.45 billion (1.1 billion), representing a

post-money valuation of roughly 0.33 x price

divided by the tangible book value (TBV which

equals a corporations total book value minus the

value of intangible assets, including brand value,

intellectual property, patents, goodwill and the like).

Over a year later, BOI traded at roughly 0.50 x price

divided by TBV, generating a 30% annualized return.

Below are some of the critical lessons PE investors

might consider in their ongoing survey of distressed

banking opportunities across the continent.

Background

In the wake of the 2008 global financial crisis,

Ireland experienced a near collapse of its financial

system, largely driven by a rapid, fundamental

deterioration in the countrys largest banking

institutions. The situation became increasingly dire

following the countrys 2008 decision to guarantee

all bank deposits and nearly all liabilities (including

forms of unsecured, subordinated debt). In the

years following the Irish governments guarantees,

the inextricable relationship between the sovereign

and its main banks only intensified.

While all of Irelands principal banks suffered from

similar exposures, fundamental deterioration, lax

regulations and flawed strategies, only the BOI

received substantial non-state equity capital. More

generally, the Irish banking crisis featured many of

the same issues afflicting banks of other developed

countries. However, unlike the banking issues

within the United States and other EU nations, the

Irish crisis was almost entirely related to property

speculation and the explosive domestic housing

bubble of the preceding 10 years.

During this period, a race to the bottom to gain

market share among growing developers and

builders ensued among Irelands largest banks. As a

result:

Property-related lending accounted for 80%

of credit growth among Irelands principal

financial institutions.This growth bolstered

government coffers with significant, albeit

unsustainable, revenues. Tax cuts and other

reforms correspondingly followed, leaving the

Irish government with little to no room to suppo

the economy (and, by extension, its ailing banksoutside of significant policy tightening in the face

of falling output and rising unemployment.

Fundamental deterioration among the most

aggressive lending institutions led to a crisis of

confidence among more viable lenders. That made

an issue that might have otherwise been containe

to one or two large banks endemic to all.



As property lending expanded, the quality of

the loans deteriorated,exposing the Irish banks

to serious stress when underlyingproperty

exposures deteriorated.

Bank of Ireland, Restructurings andImplications for Investors

Founded in 1783, BOI derives a majority of its

business from mortgage lending in Ireland and

through other financial services throughout the

United Kingdom, including business banking and

deposit gathering. Within Ireland, BOI holds either

the first- or second-largest market share across

most key products, such as residential mortgages,

personal accounts and credit cards. Going into the

crisis, BOIs strategy and balance sheet reflected

many of the problematic symptoms endemic to

large lenders afflicted by unprecedented liquidity

followed by rapidly deteriorating fundamental

conditions:

Loan and asset growth. From an alreadysubstantial basis of 80 billion in 2005, net loans

still managed to grow at an astounding rate of

nearly 20% over the next three years.

Extensive and expensive leverage. Return on

Average Assets (ROAAs) was tiny compared to

Return on Average Tangible Common Equity

(ROATCE), which was very high prior to 2007.

Meanwhile, net interest margins at less than 2%

over the past eight years suggested extensive

use of leverage relative to fundamental cash flow

generation.

Rapid escalation in impaired, delinquent,

charged-off loans (particularly among Irish and

UK-based property and construction borrowers).

Between 2004 and 2009, every absolute and

relative measure of the BOIs distressed assets

escalated materially, particularly among property

and construction borrowers, which represented a

disproportionate 58% of total loan loss provisions

compared to only 26% of gross loan exposures.

Fundamental strains to the system continued to

compound within Irelands banking system and, in

the wake of Lehman Brothers collapse, liquidityand solvency contracted among credit providers

globally. The prospects of an outright credit

system collapse within Ireland escalated rapidly.

In response, a series of bailouts, reforms and

restructurings unfolded over the next three years,

thereby laying the groundwork for the WL Ross

transaction. The following points highlight the most

salient lessons for PE investors who are considering

similar situations:

Uncertainty as an ally: Fundamentals-oriented

investors think that the markets perception of

uncertainty can create significant gaps between

intrinsic and realizable value. Todays landscape

for eurozone banks contains seemingly endless

uncertainty, which, depending on market sentiment,

can stretch that value gap beyond what facts should

justify. In Irelands case, market rumors regarding

haircuts (a reduction to less than full repayment) for

senior bondholders of liquidating banks increasingly

plagued BOIs securities throughout 2011, throwing

the proverbial baby out with the bathwater.

But any investor with access to Google might

have seen that not only was BOI more favorably

capitalized, provisioned and asset-healthy than its

liquidating peers, but also that Irelands government

had explicitly stated haircuts for BOI were off the

table. That made the Banks then valuation of 0.1

times the price, divided by the tangible book value,

a relative bargain. In todays intensely uncertain

eurozone banking environment, many investors willlikely take a fact agnostic approach to selling at

even the slightest hint of concern. For the diligent

investor, such selling could provide the ripest

investment opportunities.

Pretty pigs and sacred cows: Most eurozone

banks today remain in varying degrees of distress.

While stock prices have rallied over the past year,

significant risks remain to the downside, many

analysts agree. With this in mind, investors must be

sure they have a high level of confidence in their

management and their strategy to deal with deeply

distressed scenarios. So-called clean balance sheet

bargains will likely prove rare. Despite this distress,

some banks will be stronger and better positioned

(pretty pigs), and more systemically important for

their given economy (sacred cows).

For Ireland, BOI was both and, in March 2011, the

government announced its explicit intention to

rebuild the banking system around BOI and its next

largest competitor. Ireland would seek to ensure

BOIs survival. Despite this, the banks shares still

traded at levels implying non-survival, allowing

WL Ross to get a deal. Investors should seekto understand the timing and magnitude of the

prospective capital needs of those institutions that

have the right blend of sacred cow and pretty

pig. Investing when those needs for support become

most dire should minimize downside loss potential.

Charging for confidence: Market confidence (or lack

thereof) can translate to life or death for banks in

struggling eurozone countries. The more a bank can



14

do to regain that confidence, the less the government

will have to commit in order to keep it solvent.

The Irish government, which prior to the WL Ross

investment held approximately 36% of the bank, did

not need to raise capital with this group of investors.

But in doing so, Ireland reduced its politically

sensitive exposure to the bank and signaled to the

world that brand name institutional capital was

willing to invest. This was a critical market-basedvalidation. Ireland was wildly incentivized to obtain

such validation the sooner BOI could graduate

from taxpayer to institutional capital, the sooner

its government could begin positioning other

nationalized banks to do the same.

As such, these investors were able to charge

Ireland for that validation in the form of a remarkably

cheap valuation. Potential investors in eurozone

banks today also could seek to leverage the

prospects of early market validation and the benefits

it would bring in exchange for in terms of valuations

Today, BOI continues to thrive, having recently

completed a significantly oversubscribed issuance

of contingent convertible bonds, providing further

evidence of the markets faith in the bank and its

recovery prospects. This, in turn, has continued

to benefit WL Ross and in part validates thelessons described here. These lessons, however,

provide only a subsection of the PE playbook for

eurozone banks. Examinations of other failures and

restructurings should prove instructive as investors

continue to navigate the inherent complexities

and opportunities presented by European banks.

This article was written by Victor Dupont, a member

of the Wharton MBA Class of 2013.



I Hyd s f stakeover, the boss would grab control of a company,

throw out the slackers, move into the corner office

and start barking out orders. The message is, its

my way or the highway!

But what makes for good drama on the screen

doesnt necessarily work in real life. When a private

equity (PE) firm buys a portfolio company, its much

more like a romance instead of a war movie. For the

new partnership to work, both parties must really

believe they will be better off together instead of

alone.

A successful PE investment is the result of careful

research before the purchase, smooth relations with

the firm afterward, creation of a clear plan focused

on just a few priorities, and disciplined execution.This model for PE success was relayed by five PE

executives who spoke on a value creation panel at

the 2013 Wharton Private Equity & Venture Capital

Conference.

While the strategies for managing each portfolio

company can vary widely, the panelists agreed

on a key feature that leads to success: Instead

of micromanaging, PE owners must furnish the

company with a top-quality CEO (ideally for the

duration of the investment) and provide the leader

with advice and support along the way.

Picking the Best Fruit

A critical element of success comes at the earliest

stages before the investment has even closed

with the careful selection of the portfolio firm, said

Bill Fry, managing director of American Securities.

Most PE executives agree that the ideal target is not

a train wreck but a firm with just a few areas that

need improvement. Sometimes a firm has grown

too big and complex for the founder to manage

alone. The company may need financing, help in

streamlining systems and operations, or advice onwhich products or services to develop next. But at

its heart, the ideal target firm is sound. Typically,

the PE firm seeks to target a good core business

that maybe has lost [its] way, said Ashley Abdo,

managing director of M&A at The Gores Group.

When a target firm starts offering itself to PE

partners, it may produce a list of 12 ways to grow

and improve performance, said Fry. Sometimes the

targets investment bankers push the firm to produce

a long list, thinking multiple options for enhancing

performance make the analysis look more thoroughand make the deal appear more promising.

Over time, as the company is pitching it, they come

to believe all 12 of those things, Fry said.

But in truth, the company may only have three or

four areas that present real opportunities. A PE firm

needs to separate this wheat from the chaff during

the due-diligence process that precedes the decision

to buy, he noted. Then it needs to get the targets

management to focus on what they really believe

in versus what they are selling, he explained.

The flip side of that is, if there are 12 things [that

need improvement], you probably dont do the

deal, added Abdo. Moreover, the target firm must

not present too much risk of loss, he continued. If

there is not enough downside protection, we dont

even talk about the upside. Capital protection is the

name of the game, said Abdo.

How Do Private Equity Firms Create Value?
http://www.whartonpeconference.org/panels.phphttp://www.whartonpeconference.org/panels.phphttp://www.whartonpeconference.org/panels.phphttp://www.whartonpeconference.org/panels.php



Provided due diligence and preparation are

completed before the sale is closed, the PE firm

does not have to waste time afterward figuring

out the next move. Were looking at places where

we can immediately accelerate growth, said Tom

Shaffer, director at Alvarez & Marsal.

CEO Cooperation and Cohesion

Whether the target companys CEO came with thepurchase or was installed by the PE owners, the

panelists agreed that this leader must be an eager

supporter of the new owners strategy. Several said

they used a 100-day plan that starts on the day

the deal is closed. This plan does not leave time to

bring a resistant CEO around, though executives

with qualms do often see the benefits of the PE

relationship once the strategy becomes clear.

Once the CEO comes over and says, Okay, these

[PE] people are smart people and they can help me,

we usually do pretty well, Fry said.

For instance, the CEO may be a founder whose

firm has grown too big to handle alone. If the PE

partner has a clear strategy, youll literally see the

CEO relax in his chair and say, thank God theres

someone coming in to help, said Shaffer.

The experts provided by the PE firm are not there

to tell the CEO what to do day-by-day, but to flesh

out the CEOs staff, said Abdo. Thus, added Shaffer,

the PE firm tries to avoid a combative model and

instead works to provide reassurance that the CEO

and PE experts are on the same page and working

together. Its important to allay those concerns, he

said.

I would add that its all about alignment, said Seth

Brody, operating partner at Apax Partners. The CEO

and the PE management team must share a vision,

and managers of the portfolio firm must be replaced

if they dont share the PE owners views, he argued.

Aligning Interests on the Inside andOutside

The panels moderator, Geraldine Sinatra, a partnerat Dechert LLP, a law firm that advises various

players in the PE arena, asked how the PE firm

makes sure the acquisitions management is on

board with the strategic plan.

At American Securities, this process often begins

with a breakfast the morning after the sale closes,

since legalities and other issues can limit contact

before the deal is complete, said Fry. A series of

meetings, and then a retreat a couple of weeks into

the partnership can help ease the worry and clear

away the sense of mystery, he said.

Some PE firms conduct large meetings that

include the acquisitions managers, customers,

vendors and suppliers, noted the panelists. These

gatherings make each player better aware of the

others concerns and allow individuals to have morface-time with one another.

Another technique to ensure goals are aligned is to

bring together the CEOs of all the PE firms portfolio

companies once a year, said Abdo. Its a very

powerful couple of days, he said, part catharsis,

part networking. Often, the CEOs find they are

facing similar challenges. Sharing their concerns

with one another leaves them feeling less isolated

and more connected, said Abdo.

PE firms also typically put their own people on

the acquisitions board to ensure the new strategicplans are being executed. The people installed

on the boards could either be PE executives or

outsiders with useful expertise. American Securities

usually puts two outside directors on the board of

each portfolio firm but ensures these senior people

operate with a style thats non-threatening to the

CEO, said Fry.

In addition, its important to link compensation

for the firms senior managers to their success in

implementing the PE firms detailed strategic plan,

said Abdo. That can be very critical in ensuringgoals are aligned.

CEO Stability

Another key to value creation is stability in the

corner office, according to Fry. We start and finish

with the same CEO about 80% of the time, he said.

Meanwhile, The Gores Group has often used its

most successful CEOs on subsequent acquisitions.

We like to have relationships where they want to

come back and do another deal with us, said Abdo

Despite all these efforts, things dont always

work out. The PE firm must move quickly when

projects start going off the tracks, Abdo noted. He

recalled a case where The Gores Group bought

a Belgian company that was in financial trouble.

Gores installed a growth-oriented CEO, but the

overleveraged firm also needed to cut costs. After

some cuts were implemented, the CEO felt that mor



cuts would wreck the business, but Gores feared the

firm would go bankrupt if it didnt continue to trim.

Eventually, the CEO had to be replaced.

If youve got that misalignment, you cant just

continue to operate, he explained. One of you is

right, and one of you has to go.


20/24

Connecting Alumni in Private Equity

WPEP is the community connecting the 3,000+

Wharton and UPENN alumni who are leaders in

private equity around the globe.

An exclusive and growing network, WPEP is limitedto alumni who are GPs and/or LPs investing in

leveraged buyouts, growth capital, mezzanine,

venture capital and secondaries.

Members access resources that:

Provide unique opportunities to network with thei

peers.

Deliver the latest in market trends and industryknowledge.

Enhance Whartons standing in the private investo

community.

Support the engagement of the alumnae members

with the school.

Formed in 1998, WPEP has grown to nearly 500 members with chapters in cities around the world.

Atlanta

Boston

Los Angeles

New York

Philadelphia

San Francisco

Texas

Washington, D.C.

United States International

London

Paris

The Middle East

India

www.wpep.org

Connecting Alumni Around the Globe

Wharton Private Equity and Venture CapitalAssociation (WPE&VC), formerly Wharton PrivateEquity Partners, represents the interests of over 3,500

Wharton/UPenn alumni actively investing venture

capital, LP and private equity funds around theglobe. While we have always welcomed venture, ourre-branding is a commitment to this segment of thecommunity with plans to expand our presence andofferings. e organization brings greater knowledgeto all members through best practices, interactionand education.

Formed in 1998, WPE&VC has grown to nearly 500 members with chapters in cities around the world.

Interested in becoming a member of this exclusive global network of private equity & venture capitalprofessionals visit our website for qualications and to join, plus view upcoming events and initiatives.

Provide unique opportunities to network withtheir peers.

Deliver the latest in market trends and industryknowledge.

Enhance Whartons standing in the privateinvestor community.

Support the engagement of the alumnae memberswith the school.



Venture Capital: The Art of Picking the Few from the Many

Vu cp (VC) s b mega-industry, but many who work in the sector

seem happy with the current state of affairs.

VC funds raised $20.6 billion in 2012, Thomson

Reuters reported, but this amount is dwarfed bythe $311 billion that was raised by the private

equity industry, including venture capital, in 2012,

according to research firm Prequin.

The sector has also had some recent ups and downs

in terms of fundraising. The latest figures show

that the VC industry has shrunk since raising $25.6

billion in 2008, but is recovering from the depths of

the financial crisis in 2010 when fundraising fell shy

of $14 billion.

When it comes to looking ahead to the future of the

VC industry, speakers on the venture capital panel

at Whartons 2013 Private Equity & Venture Capital

Conference were optimistic about producing strong

returns for their investors despite a new normal

that may leave the industry with less money to work

with for the foreseeable future.

In some ways, [our relatively small size as an

industry is] a good thing, because venture capital

as an asset class is hard to scale, said Imtiaz

Kahn, principal portfolio manager for pension

and endowments at The World Bank. As an

investor looking for promising VC funds, Kahnrealizes that the business of investing in young

companies is inherently difficult and risky. The key

to success is taking care in picking the few really

good opportunities from the many, he noted, and

remembering that there are always some stars

whether the market is growing or shrinking.

Since venture capital is so inherently risky, it is hard

to generate consistent returns over the long term,

which keeps investors from pouring assets into the

sector, Kahn said. Its difficult. You want to go with

the best-returning funds, and those are limited.

The bar is really high for adding a new fund to ourportfolio. We havent added a new venture capital

firm in a few years.

Limited funding for the industry does have its

benefits, added Michael F. Bigham, a partner at

Abingworth, a VC firm with offices in London,

Menlo Park, Calif., and Boston that specializes in

life sciences and health care. There are still plenty

of young firms to invest in and prices are good, he

said, and if too much money were to flow into the

industry, prices might increase to the point where

it is difficult to make profitable investments. Overthe long term, conservative funding will be very

healthy for the industry, Bigham noted, predicting

good returns over the next five years.

The VC Funding Evolution

Funding for the VC sector has evolved in recent

years, leaving what some describe as a barbell-

shaped industry a few very large funds, a lot of

very small ones and little in between. There is

a paucity of $100 million to $500 million funds,

said Matt Harris, managing director of Bain Capital

Ventures, the venture operation at Bain Capital.Only a few years ago, most funds fell into this

mid-sized category, he added.

The recent trend toward very big and very small

funds has occurred because limited partners have

been attracted to the high-performing funds, which

has helped them grow even larger, while others have
http://www.whartonpeconference.org/index.phphttp://www.whartonpeconference.org/index.phphttp://www.whartonpeconference.org/index.phphttp://www.whartonpeconference.org/index.php



20

moved to small funds that operate in niches that are

too modest to soak up money, explained Harris.

Large investors, such as pension funds, gravitate to

the big VC operations because it is too difficult for

these investors to perform due diligence on a large

number of small funds, Kahn added. Meanwhile, the

very small funds are big enough to serve the needs

of wealthy individuals and families, he said.

New Opportunities

While money is tighter than it once was, panelists

at the Wharton conference agreed that investment

opportunities abound.

All the Wall Street guys who used to brag about

the cool restaurants they were invested in are

now bragging about the tech companies they are

invested in, joked panel moderator Brett Topche,

managing director of MentorTech Ventures, a seed-

and early-stage venture capital fund that invests

in companies that emerge from the University ofPennsylvania.

New companies in need of VC support are springing

up at a rapid clip, said Harris. Many of our young

people are deciding to be entrepreneurs, he noted.

Its a wonderful thing.

This rise in entrepreneurship is due to the fact

that it is now fairly easy and inexpensive to start

a software company, explained Adam Enbar, a

team leader at Charles River Ventures, a Boston

and Menlo Park, Calif.-based VC firm focusing on

technology and new media. Many tech start-ups,for instance, are developing applications for

smartphones and tablet computers, he said.

This environment can be challenging for a VC

fund trying to separate the good opportunities

from the bad. Some start-ups are jumping on the

bandwagon, trying to cash in on an idea that has

already been successfully developed by another

firm, Kahn noted. I think thats sometimes

concerning, he admitted.

While Harris agreed that there are many me too

ideas in the market, he cautioned investors against

immediately writing off a young firm with an

unoriginal idea. Original ideas can begin to surface

once a company starts making progress, he said.

One thing we know about entrepreneurs is that

where you start is sometimes very different from

where you end, he noted.

VC funds can also find opportunities in markets

that dont have a lot of pizzazz, Harris pointed out

For example, over the last decade Harris has been

working with firms that are developing alternative

payment systems, such as variations of PayPal for

retailers, which provide easier business-to-business

transactions. He has also been looking at ways to

use new types of data to underwrite consumer and

business lending. I do a lot of payment stuff. I thin

there are many more chapters to that book, he said

The panelists also discussed the rise of New York

City as a tech center that is challenging Silicon

Valley. You dont have to be in Silicon Valley

anymore, Enbar noted.

Twenty years ago, a tech start-up would have had

a tough time hiring engineers and finding capital

if it was not in Silicon Valley, Enbar added. But in

recent years, start-ups have begun to think more

about where their customers are located. If youre

thinking about where your customers are, more

often than not theyre in New York.

A Word of Advice for YoungEntrepreneurs

Topche asked what advice the panelists would give

to young people interested in starting companies, o

in joining start-ups.

Find a company thats exploding, said Enbar,

observing that it is fairly easy to start a business

but difficult to make one grow. Though the idea of

joining a firm with only five employees may seemappealing, more likely than not youre just going to

learn how a company fails, he noted.

Young entrepreneurs should also think about

their firms long-term prospects, Enbar added.

Dont work on problems that are difficult and

unimportant, he said. If youre going to do

something, make sure youre solving a problem tha

will keep you going beyond the [VC backers] exit.

Harris said that when he thinks about whether to

back a young firm, he looks for what drives the

entrepreneur, favoring ambition that originateswith a life lesson, not a whiteboard. He prefers

individuals who are focused on an idea, not just on

getting rich.

In the absence of an authentic impulse to go build

something, dont build something, he advised.

Instead, join a company thats already building

something.


23/24


24/24


2013 Wharton Private Equity Review:

Navigating the

New Normal


Documents

061013 Navigating the New Normal R6 PE